Oil Market update

Clive Maund
March 6th, 2007

Oil and oil stocks have behaved pretty much as predicted in the last update on 15th February, although oil has pushed a little further into overhead resistance than expected, while oil stocks have declined as expected with the broad market. Barring the prospect of an imminent attack on Iran, oil now looks set to head lower soon, and this should result in the oil stock uptrend finally failing. Oil stocks have been surprisingly resilient considering the magnitude of the drop in crude from July through to early this year.

On the 1-year chart for Light Crude we can see how oil regrouped in the middle of February and launched another assault on the heavy resistance close to the underside of the long-term uptrend line, which it had broken down from so spectacularly in January. Due to the strength of this resistance the move didn’t get far, and now oil is struggling and regarded as vulnerable to a downturn here very soon - a “Distribution Dome” appears to be forming beneath this resistance. Gas prices weakened late last weak, with gas stocks such as Abraxas (ABP) breaking lower, not a good omen.

On the 6-year chart for Light Crude, we can see how the position is little changed from the last update, with oil pushing its luck as it valiantly struggles to reinstate its former bullish picture by climbing back above its long-term uptrend line. Unless an attack on Iran looks inevitable and imminent, or suddenly occurs without warning, which is possible as the logistics are in place, it is not expected to succeed, and should therefore going into retreat soon. Oil is therefore viewed as a short sale here, with a close overhead stop to take account of the Iran factor. The upside breakout point for oil, that would immediately put it back into bull market mode, is $64.40 on the Light Crude chart.

An important question now that oil has broken down from its long-term uptrend is “Is oil now in bear market?” The answer to this question is that it is not thought to be in a bear market, but rather to have entered into a lengthy correction to the 5-year long uptrend that preceded the breakdown. Barring an attack on Iran this corrective phase could well last for a year to 18 months.

With respect to the outlook for oil stocks the corollary of the above deductions regarding the outlook for crude, is that oil stocks are now looking set to finally break down from their uptrend, shown on the accompanying 2-year chart for the OIX oil index. They have remained amazingly buoyant considering the mauling meted out to oil itself late last year. The reasons for this are, of course, not hard to find; huge windfall profits are still flowing into oil company coffers from the high oil price during the first half of last year, and, until just this past week, oil stocks have been underpinned by the seemingly endless, steady uptrend in the broad market. The uptrend in the broad market ended in an undignified rout last week, and although oil stocks haven’t so far broken down from their uptrend as a result, they suffered significant damage that brought them down close to the lower support line of their uptrend channel, so that now, with oil itself looking set to turn lower, they are believed to be close to breaking down from the channel, particularly if the broad market deteriorates further at the same time. A break above $64.40 on the Light Crude chart, however, as mentioned above, would be expected to suddenly throw oil stocks back into bullish mode.